Bank gets an IMF pounding

WHO would want to sit on the Monetary Policy Committee? You are damned if you change rates and damned if you don't. At the March session, the Bank of England decided to hold fire.

Complaints have rolled in from all the usual sources. They include the TUC, the British Chambers of Commerce, the CBI and all those involved in manufacturing. Despite the lowest UK interest rates in 40 years, these groups want to see them even lower.

On the other side of the debate is the strength of the consumer economy. Much of this can be traced to the extraordinary buoyancy of the housing market. As broker Gerrard notes on the basis of the latest Halifax data, property prices are now 16.9% higher than a year ago, and the pace of expansion is at its highest level since the 1980s. This is enough for the International Monetary Fund to worry 'it is a cause for concern' in its annual inspection of the UK economy.

These issues have provoked division within the MPC. The hawks believe that interest rates need to target the strong consumer sector, and this means keeping them higher than is necessary to meet the Government's 2.5% inflation target. This could mean Sir Eddie George, the governor, having to write to Gordon Brown explaining why the target is being undershot.

The doves still have worries about the weakness of the world and British economies (there was, after all, no UK growth in the fourth quarter). They believe that the MPC should stick to its mandate. This might even lead to lower interest rates, as manufacturers are demanding.

But while lower interest rates might provide heavily borrowed industries with some relief on debt charges, there is no guarantee that rate cuts will lead to a more competitive exchange rate for the pound. Contrary to popular belief, lower interest rates in the last economic cycle were associated with a rising pound, as the markets counted on future expansion.

Just how far sterling moved between mid-1996, just before Labour came to office, and the end of 2001 is quantified by the IMF. It estimates that it rose by at least 30% (on a measure based on consumer prices) but by a 'spectacular' 40% if labour costs are taken into account.

The extraordinary thing, in the IMF view, is that the relatively high exchange rate has so far had only a modest impact on the nation's trade balance. It suggests the worst of the impact on exports and the manufacturing sector already has been absorbed.

After six years of manufacturing downturn that might seem to state the obvious. Clearly, though, an exchange rate which has inflicted damage on the manufacturing base needs to be corrected. The difficulty is that the most obvious solution - cutting interest rates - has not helped so far.

Rolls holds its nerve ROLLS-ROYCE provides a useful example of a manufacturing business able to escape the worst impact of the robust pound, because it is a long way up the technology chain. It also quite usefully competes with US aero engine makers, who have to work with an even stronger exchange.

Since September the company's shares have been under enormous pressure, falling from a peak of 250p last year to 121p, and picking up to 182 3/4p in latest trading.

Rolls chief executive John Rose has made no secret of the fact that 11 September will have a serious effect on 2002 results, and the company has anticipated this with a rationalisation programme. What has impressed the market is that it outperformed expectations last year and believes that firm orders for 2003 and beyond should ensure an uplift ahead.

There have also been some sensitive issues in the wake of Enron. The company's fondness for 'risk sharing partnership' and joint ventures has raised eyebrows in the analytical community. It has been argued that this is a smart way of shifting liabilities off balance sheet.

Rose says the company is not guilty as charged, and points out that, in total, the deals concerned involve 5,500 people, £200m in net assets and £780m in debt - not enough to sink the company even if they all were to turn to custard.

Its other problem is the £387m shortfall in pension funding at home and overseas. For the moment Rolls sees this as a temporary market phenomenon which, with a bit of luck and a take-off in equity markets, might resolve itself. The critical point for the group's pensioners will come at the end of the next triennial valuation in 2003.

If the hole in the fund deepens, then there must be a real possibility that the final benefit pension may have to be reviewed. But unlike Marks & Spencer and others, Rolls is holding its nerve. For that alone it deserves respect.